Here's why RF Micro Devices (Nasdaq: RFMD) may be cheaper than you think.

In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.

This is the primary metric we use to mark corporate progress. Earnings, or net income, are also the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.

Unfortunately, "earnings" figures don't always give you the full picture.

Let me explain
Reported earnings are an accounting construction that may or may not accurately reflect a company's true earnings power. Free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate metric that can help you identify cheap stocks.

Better still, it's one that other investors frequently overlook. That means investors like us who peek at free cash flow can gain a significant advantage in the market.

There are a number of reasons why net income may understate a company's true profitability. Considering this overlooked-but-critical metric can give you an advantage over other investors.

How RF Micro Devices stacks up
If RF Micro Devices tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if RF Micro Devices consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.

This graph compares RF Micro Devices' historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)



Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

As you can see, RF Micro Devices has a tendency to produce more free cash flow than net income. That's because over the past couple of years it has spent far less on new capital expenditures than the depreciation charge on past ones. If that continues -- and management only expects to spend around $20 to $30 million in capital expenditures for 2011 -- the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.

Let's compare RF Micro Devices to the wider semiconductor field for additional context:

Company

Price-to-Earnings Ratio

Price-to-Free-Cash-Flow Ratio

RF Micro Devices

14.8

7.9

Intel (Nasdaq: INTC)

10.6

10.3

Skyworks (Nasdaq: SWKS)

21.9

30.6

Cree (Nasdaq: CREE)

36.8

164.7

Median Semiconductors*

16.4

17.7

*Of mid- and large-cap domestic stocks.

RF Micro Devices appears cheaper than many of its peers. Its free cash flow multiple is also considerably less expensive than its earnings multiple. RF Micro Devices may be much cheaper than investors realize.

Ilan Moscovitz doesn't own shares of any company mentioned. Intel is a Motley Fool Inside Value pick. The Fool owns shares of and has written puts on Intel. Motley Fool Options has recommended buying calls on Intel. The Motley Fool has a disclosure policy.